Short term sacrifice

MANILA, Philippines — It may at first seem to be too big and bitter a pill for electricity consumers to swallow.

It is a pill that we might need to take for only six months, but it can avoid a much bigger problem in the long term and one that will be beneficial in the longer run.

The Energy Regulatory Commission (ERC) is expected to decide next week on the joint petition of SMC Global Power (SMCGP) and Meralco for a temporary, six-month rate increase on its two 2019 power supply agreements (PSAs), one for the Sual coal-fired power plant and the other for the Ilijan natural gas plant.

If granted, it would result in a 30 centavo per kilowatt hour increase in electricity rates for a period of six months.

These are two of the very last, consumer-friendly, fixed-rate PSAs of Meralco. Under these PSAs, Meralco pays a fixed rate every year for capacity delivered. Any additional cost to produce electricity, such as higher fuel prices, are absorbed by the SMCGP facilities.

In contrast, most other power generation firms just pass on the cost of higher fuel prices to consumers in the form of higher generation charges.

For proper context, when the Sual plant PSA was signed in 2019, the rate was based on the prevailing and projected price of coal for the next 10 years, which was only at $60-$65 per metric ton.

Unfortunately, events beyond SMCGP and Meralco’s control happened, including the Russia-Ukraine conflict which has disrupted global energy markets. Soaring natural gas prices following Russia’s invasion of Ukraine have propped up world demand and use of coal, with demand expected to increase next year to a new all-time high.

According to one report, international coal prices have hit three all-time peaks between October 2021 and May 2022. Sanctions and bans on Russian coal following the invasion of Ukraine have disrupted markets, and issues in other major exporters have contributed to supply shortages. Russia is one of the world’s top three coal exporters, controlling about 17 percent of global shipments.

A report from the International Energy Association (IEA) revealed that worldwide coal consumption rebounded by about six percent in 2021 as the global economy recovered rapidly from the initial shock of the COVID pandemic.

Meanwhile, global coal demand, IEA said, is being propped up this year by rising natural gas prices, which have intensified gas-to-coal switching in many countries, as well as economic growth in India. Those factors are being partly offset by slowing economic growth in China and by the inability of some major coal producers to ramp up production.

The IEA report noted that in China, coal demand declined by three percent in the first half of 2022 as renewed COVID lockdowns in some cities slowed economic growth, but an expected increase in the second half of the year is likely to bring coal consumption for the full year back to the same levels as last year. China and India together consume double the amount of coal as the rest of the world combined, with China alone accounting for more than half the world’s demand.

The same report revealed that coal consumption in the European Union is expected to rise by seven percent in 2022 on top of last year’s 14 percent jump, driven by demand from the electricity sector where coal is increasingly being used to replace gas, which is in short supply and has experienced huge price spikes.

IEA emphasized that with other coal producers facing constraints in replacing Russian output, prices on coal futures markets indicate that tight market conditions are expected to continue well into next year and beyond.

From 2021 to the present, coal prices have skyrocketed and now range between $300 to over $400.

These are fortuitous events which Meralco and SMCGP could not have anticipated when they entered into these fixed rate PSAs and these change in circumstances beyond the control and reasonable foresight of the parties justify a review of the terms of the PSA between the two parties.

SMCGP cannot continue absorbing the coal price increases which is why it is requesting for temporary relief.

Given the losses already absorbed by the power facilities starting 2021 when fuel prices started going up, made even worse by the Russia-Ukraine conflict and Indonesia’s ban on coal exports early this year, denying SMGCP’s request will leave the company with no recourse but to terminate its PSAs with Meralco.

Pulling the plug in order to stem further financial losses is a ground for termination of the contract as set forth in the original PSAs that were reviewed and approved by ERC itself.

But instead of doing that, SMCGP just wants a temporary relief and an interim and tempered increase in rates (30 centavos per kWh only for six months) because the PSAs will still benefit consumers in the long turn.

The alternative, as Meralco has already bared, is a “low side” estimated increase of around P1.20 per kwh for the next three to four months, as it tries to source capacity from various other sources, including the Wholesale Electricity Spot Market (WESM), where prices as well as capacity, tend to be volatile.

Meralco announced that it has secured emergency power deals with several power generation firms, to be called only if the termination of its Sual and Ilijan PSAs pushes through in early October.

But the distribution utility was also very clear in saying that preserving the existing power supply deal with SMCGP will be the least cost option for their consumers.

That is essentially because new emergency power deals will presumably have to start at much higher rates, based on the current global prices

But there is a more compelling reason why the ERC needs to save the Ilijan and Sual PSAs by granting the temporary rate hike.

If these PSAs are terminated, it’s goodbye forever to this fixed rate pricing, which would have benefitted consumers until 2029, rendering the six-month, temporary increase almost negligible.

And we can be sure that any new supply agreements with Meralco will surely no longer feature this consumer-friendly pricing scheme which SMCGP is still trying to salvage.

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